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Penny Options

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It wasn't long ago when stock shares in the US markets were quoted in increments of 1/16 of a dollar or 6.25 cents. I always wondered why the system was designed that way. It seemed unfair that there was always a 6.25-cent margin between the ask and bid prices, while any other product bought and sold in this country was priced in penny increments. While average traders had to contend with such a big margin, you knew there was always some middle guy skimming from this system, pocketing nice profits.

There was some concern about changing the system to penny increments. Perhaps people worried that the systems wouldn’t be able to handle the stress and the penny system would have been unwelcome news to those playing the margins. The change came to pass and the sky didn’t fall. Today the average trader can specify his stock buy or sell in penny increments and we're all better for it.

Options pricing have had a similar drawback. They are still quoted in nickel increments and the average trader is shackled by this unfair system. Why should an options contract have an ask price of $.05 and a bid price of $0, when perhaps in reality its ask/bid should be $.04/$.03? Today a buyer for that particular option has two bad choices. Either pay the expensive $.05 to buy the contracts or forego the trade. The seller, would have to rely on luck to unload the contracts at $.05 or hold onto to them until they expire worthless. Options are priced similar to insurance premiums. Prices are based on their expiration times and factors associated with their underlying instruments such as volume, inherent risk, volatility and others. That generally shouldn't lead to nickel increments.

That's about to change on January 26th when CBOE (the giant options market in Chicago) will kick off a pilot program to make 13 classes of options available with penny increments. They are:
IWM - Ishares Russell 2000
INTC - Intel
CAT - Caterpillar
SMH - SemiConductor Holders
WFMI - Whole Foods
GE - General Electric
TXN - Texas Instruments
AMD - Advanced Micro Devices
FLEX - Flextronics International
MSFT - Microsoft
SUNW - Sun Micro
A - Agilent Tech

I hope the pilot proves successful and it eventually expands to include all options. We'll all be better for it.

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